• by Jack Loechner , Staff Writer, July 31, 2014

A new report from the McKinsey Global Institute (MGI), China’s Digital Transformation: The Internet’s impact on productivity and growth, projects that new Internet applications could fuel 7 to 22% of China’s incremental GDP growth through 2025, depending on the rate of adoption. That translates into 4 trillion to 14 trillion renminbi (RMBs) in annual GDP in 2025.

As individual companies adopt web technologies, they gain the ability to streamline everything from product development and supply-chain management to sales, marketing, and customer interactions, says the report. For China’s small enterprises, greater digitization provides an opportunity to boost their labor productivity, collaborate in new ways, and expand their reach via e-commerce, and  could account for up to 22% of China’s labor-productivity growth by 2025.

Yet the Internet is not merely a tool for automation and efficiency, says the report. It also expands markets rapidly. Greater adoption of web technologies in China could lead to the introduction of entirely new products and services if government and industry take the right steps to maximize the potential.

From a consumer oriented Internet, with 632 million Chinese Internet users in 2014, 700 million active smart devices, US $300 billion e-tailing sales and (4.4% of China’s Internet economy as a share of 2013 GDP) higher than the United States or Germany… to a more enterprise driven Internet

With up to 22% of the Internet’s contribution to China’s productivity growth by 2025; RMB 10 trillion annual GDP at stake by 2025, equivalent in size to Australia’s current GDP and RMB 610 billion potential annual savings in health-care expenditures by 2025

The 10 trillion renminbi gap between the two numbers represents the economic growth at stake. The low end of the projection assumes that the country’s current trajectory continues, with adoption of Internet applications increasing at a moderate pace, under existing constraints. The upper end assumes that China builds a supportive policy environment, individual companies move decisively, and workers adapt to the demands of a more digitized economy.

China is in the midst of a digital revolution, says the report. During the course of 2013, the number of active smart devices grew from 380 million to 700 million. On Singles Day, the e-commerce marketplaces Taobao and Tmall posted more than RMB 36 billion (almost $6 billion) in sales in just 24 hours. Some five billion daily searches are made through Baidu, and hundreds of millions communicate via WeChat. Tencent’s mobile messaging app. Now with 632 million users, and counting, the Internet is fundamentally altering the fabric of daily life in China.

Until now, China’s Internet has been largely consumer-focused. But that is about to change as the Internet penetrates more deeply across major sectors of the economy. As companies embrace Web technologies, their operations become more efficient, translating into productivity gains. While this process is likely to displace some workers from existing roles, the Internet also creates new markets for innovative products and services, increasing demand for workers with digital skills.

China is on the brink of a digital transformation that will enhance productivity and spur economic growth, says the report. The Internet provides a platform for millions of daily online transactions and communications that make a significant contribution to individual economies. MGI has developed the iGDP indicator to measure the size of a country’s “Internet economy.” In 2010, China’s Internet economy stood at 3.3% of its GDP, lagging behind most advanced economies. By 2013, its iGDP had reached 4.4%, moving China into the ranks of the global leaders.

China’s Internet has already given rise to a dynamic technology sector, thriving social networks, and the world’s largest e-tailing market. But the Web is just beginning to penetrate many Chinese businesses, and the most sweeping changes are yet to come, notes the report. According to McKinsey’s latest survey of CIOs, the typical Chinese company spends 2% of revenue on IT, far below the 4% international average, but respondents predict significant increases by 2015, indicating clear momentum.

This report focuses on major new uses of the Internet that could penetrate more deeply in six sectors that collectively accounted for approximately one-quarter of Chinese GDP in 2013. Assuming that the Internet has a comparable impact on the rest of the economy, the study projects that these applications, combined with the finance sector’s new capabilities to allocate capital more effectively, could enable 7 to 22% of the total increase in China’s GDP projected from 2013 to 2025

The next wave of Internet development will help China shift toward a model of economic growth that is based on productivity, innovation, and consumption. The Internet is fueling the ongoing process of moving China’s industry from less productive to more innovative and technologically advanced business models, says the report. Much of the Internet’s impact will likely come in the form of productivity gains. As individual companies step up their adoption of Web technologies, they will streamline their operations, from product development and supply chain management to sales, marketing, and customer interactions.

The speed and extent of Internet adoption will shape China’s future economic growth (RMB trillion)

China’s GDP Is Expected To More Than Double Between 2013 And 2025 (6.6% Per Year)

• GDP, 2013             57 RMB
• GDP, 2025            123 RMB

Source: McKinsey Global Institute analysis, July 2014

By 2025, new Internet applications could enable some RMB 4–14 trillion in annual GDP

• Lower adoption case: Current trajectory    4 T RMB
• Higher adoption case: Aggressive government/ industry effort    14 T RMB
• % of total growth   (7% to 22%)

The Internet is already generating enormous economic value in China. To illustrate the transformations taking place across the economy, the research analyzes six sectors representing a mix of industry and services, of discrete and process manufacturing, and of corporate and semi-public sectors. Companies are beginning to revamp traditional business processes to achieve cost savings, and in some cases, new billion-dollar markets have taken shape virtually overnight.

At the same time, says the report, the Internet can unleash creative destruction. Since volatile industry dynamics will be at work, the research does not attempt to predict winners and losers. Instead, it examines major new Internet applications that are beginning to penetrate various sectors and takes a macroeconomic view, quantifying the value they can create throughout the economy. The results may not appear all at once, as companies will have to undertake considerable investment in the near term. But the impact will accelerate over time, and by 2025 the contribution to annual GDP will be substantial.

Adoption of new Internet applications in these sectors will have substantial economic impact

Government entities at all levels now have an opportunity to increase their own effectiveness through the use of Web-based systems and tools. In their role as regulators, policy makers need to be fluent in the language of technology so they can participate in the flow of discussion with industry players and keep current with the latest innovations. The Internet’s growth will require a policy framework that addresses these issues:

• Enhancing privacy protection and data sharing
• Liberalizing markets to encourage new innovations
• Developing workforce skills
• Expanding Internet infrastructure and setting standards

Transforming a traditional company into a digital business involves rethinking everything from company culture to strategy, operations, organization, and partnerships, says the report. Some of the major considerations for business leaders are:

• Cultivating a “customer first” mentality
• Adjusting strategy to prepare for a new wave of competition
• Transforming operations
• Acquiring the right capabilities and determining the right organizational structure
• Becoming more open to partnerships and outside collaboration

Concluding, the summary says that with some 632 million users, China is already the world’s largest Internet market. But its economy is on the cusp of an even greater wave of transformation as Chinese businesses go digital. Previous MGI research has found that a country’s Internet maturity correlates with a sizable increase in real per capita GDP. In other words, this shift can deliver growth and productivity gains that support higher living standards. The Internet may bring disruptive change, but companies that successfully compete at the forefront of innovation stand to create enormous value.

For more detailed information and the PDF file with additional charts and graphs, please visit McKinsey here.